Posted : 2011-06-21 17:26
Updated : 2011-06-21 17:26

Investment banking becomes a must

Korea hopes to foster national champions that hold their own against global IBs

By Kim Da-ye

It was more talk than action when domestic securities firms said they were aspiring to transform from brokerages to global investment banks (IBs).

However, they now have no other choice than try hard to put that into practice as the introduction of “Korean-style” hedge funds will create a strong demand for investment banking.

The Financial Services commission (FSC) last week laid out details for the revision of a financial law that would allow the creation of hedge funds here. The authorities are hoping that the revision will go into effect in September and hedge funds designed under domestic regulations will pop up by the end of the year.

Hedge funds require prime brokerage services for their activities, especially shorting. Short-selling involves borrowing stocks and selling them with the expectation their prices will fall in the future and buying and paying back the same shares when the prices actually fall. The practice requires prime brokers.

Prime brokers generate most of their income from lending securities while clearing hedge funds’ trades and managing their assets. Goldman Sachs and Morgan Stanley nearly dominate the market although there are smaller players, including international financial giants such as Credit Suisse and Deutsche Bank.

Korean experts have raised concerns that the global IBs will continue their dominance in Korea and domestic securities firms could be left out of the new opportunity.

“Global investment banks that have provided prime brokerages services in the past have an absolute advantage as they have large accounts, wide stock portfolios and a global network. With economies of scale, global firms can lend shares at competitive costs,” Park Nam-young of Shinyoung Securities said Tuesday at a discussion arranged by the Korea Exchange (KRX).

A key capacity of a prime broker is being able to lend a variety of shares in the requested volume at a relatively low cost. Size is critical.

Shin Bo-sung, a researcher at the Korea Capital Market Institute (KCMI), recently said in a column that the average size of equity capital belonging to Korea’s top five securities firms is one 30th of a global IB’s.

“Korea’s largest securities firm’s equity capital is 2.8 trillion won, and that’s one tenth of Japan’s Nomura Securities. The capital at China’s largest brokerage, CITIC Securities, had been smaller than that at large Korean firms until 2005, but it grew to four times as large as that of the largest Korean firm in 2010,” Shin said.

Shin argued that the Korean securities industry lacks a market leader, and that brings down the standard for the entire sector.

“Large and small companies became homogenized without differentiating products and services. When their products are similar, prices are the only element in competition,” Shin said, pointing out that the commission collected by local firms for managing initial public offerings (IPOs) and underwriting corporate bonds is less than half of that charged in the U.S.

Are there any Korean securities firms that may eventually rival international giants?

Kim Ji-hyun, an analyst at Hi Investment & Securities, picks Samsung Securities as a potentially competitive prime broker because it has the largest pool of shares to lend.

The company, well-known for strong wealth management services, is known to have stocks worth 181 trillion won consigned by its clients.

For now, even qualifying as a prime broker is expected to be highly challenging.

The financial authorities said it would later set separate requirements for prime brokers, and experts forecast the minimum requirement for equity capital would range between 2.5 trillion and 3 trillion won. Only a few brokerages would meet that standard.

According to data compiled by Hi investment’s Kim, Daewoo Securities tops the list with the an equity capital of 2.86 trillion won, followed by Samsung Securities with 2.8 trillion won, Hyundai Securities with 2.67 trillion won, Woori Investment & Securities with 2.63 trillion won, Korea Investment & Securities with 2.42 trillion won, Shinhan Investment with 1.93 trillion won, Mirae Asset Securities with 1.89 trillion won and Daishin Securities with 1.71 trillion won.

Securities firms will also have to choose between becoming a prime broker or managing hedge funds as regulations won’t allow a company to assume both roles due to a conflict of interest. Qualified securities firms are likely to provide prime brokerage services while spinning off hedge fund management units.

While taking up a strong position in the market early is considered an important strategy for prime brokers, Shin of the KCMI reveals a brighter side. He said that the introduction of hedge funds could encourage brokerages to raise their equity capital and strengthen their IB roles.

“Brokerages have so far made little progress in becoming larger because the size of the capital wasn’t an important factor in competition,” Shin said.

“Prime brokerage services need considerable capital. From this perspective, hedge funds will bring about changes for brokerages to strengthen their IB roles.”

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